On the face of it, PepsiCo (PEP) stock’s recent performance has been very similar to that of other consumer defensives. That is to say, earnings growth has been fairly subdued, with shareholder returns primarily a result of certain ‘unsustainable’ measures. What do I mean by this? Well, the most common criticisms include dividend increases in excess of earnings growth, debt funded stock buybacks, and market exuberance leading to undeserved valuation expansion.
The headline numbers seem to support that thesis. For example, back in 2012 the company posted total revenue of $65.5b. That figure had actually decreased slightly to $64.6b by the end of 2018. The earnings numbers look a bit better but are nothing to really shout home about. In 2012, the company made a net profit of around $3.90 per share. That had increased to around $5.25 per share by 2018 – with quick math putting average annual growth at circa 4.9% in that period.
Meanwhile, shareholder returns have decisively beat those headline numbers. I mean, you could purchase the stock for around $69.15 at the start of 2012. That had risen to around $110 by the end of last year. On top of that, the company paid out cash dividends worth around $17.25 per share. If you let those distributions pile up in a bank account somewhere, then you would have generated a total return of 95%. Reinvesting them into more stock made you an extra ten percentage points on top.
The Underlying Profit Machine
Helpfully, PepsiCo actually breaks down its headline numbers into quite a bit of detail. Check out what happened in 2015. The headline number that ends up being quoted shows normalized earnings per share (“EPS”) of $4.57, down a disappointing 1.3% on 2014 EPS of $4.63. From those figures, it looks like the company is going into reverse gear. Remember these represent normalized profit, so we can’t even blame certain one-off hits such as the impairment to the Venezuelan business.
However, what these dollar dominated numbers don’t represent are foreign currency movements. These cost PepsiCo a massive 11-point hit to the per-share net income figure that year. Or put another way, it reported an EPS drop of 1% rather than growth of 10% solely because it publishes its accounts in US dollars.
These swings can reach absurd levels in some places. For instance, check out what was going on in the Europe Sub-Saharan African segment that year. It reported segmental net revenue of $10.5b, down over 20% on its 2014 level. Operating profit for the segment fell by the exact same amount. This isn’t some trivial part of the company’s business we are taking about here either. Europe is a big market for PepsiCo, with that segment as a whole accounting for one out of every five dollars in total sales.
Now, to the shareholder based at home in the USA, that performance looks utterly awful. The company must really have sold way fewer bottles of Pepsi and bags of Lay’s chips, right? Perhaps management slashed prices in order to entice consumers? Maybe even a combination of both of those things? Nope. It was actually entirely down to unfavorable currency movements. In fact, to the PepsiCo executives stationed on the ground in Europe and Africa, business probably looked fairly good. The company actually sold both more sodas and more snacks in the region that year than it did in the year before. In currencies such as the British Pound, Polish Zloty and South African Rand, the results would have looked fine.
A few things become apparent when you digest these currency movements and back out non-recurring expenses. First of all, it is incredible how stable the company’s underlying business has been. It has hummed along generating core profit growth in the 9% per annum range over the past five years. The second thing you may have noticed is that this figure exactly matches PepsiCo’s dividend growth rate in that time. I’m sure this isn’t a coincidence given management has a full view of the big picture. Far from being a result of undeserved exuberance, PepsiCo’s returns look justified by the company’s operating results.
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